Yum! Brands: How Little Things Bring a Company Down

Now, after all of that success and effort, some tainted chicken in China has battered Yum!’s reputation. That just shows how little it takes to sweep a reputation away, even one that has been constructed over years.

The big backlash against Yum! started a few hours after it announced fourth-quarter earnings and its share price fell. Brokerage Baird dropped its price target to $60 from $72 and cut its rating on Yum! Brands to Neutral, which is Wall St.’s word for “sell.” Shares traded at $63.84 before the company released its numbers.

Yum! made an absurd attempt to put the Chinese chicken problem backstage. David C. Novak, chairman and CEO, said:

We delivered full-year 2012 EPS growth of 13% or $3.25 per share, excluding Special Items. This marks the 11th consecutive year we delivered at least 13% growth, which puts us in an elite group of high-growth companies. We also take satisfaction with our record level of international development in 2012 which lays the foundation for future growth and makes Yum! a leader in emerging market development. With new-unit development at the core of our growth model and the continued rapid expansion of the consuming class overseas, we believe our opportunity for long-term growth has never been better.

As the market’s reaction to the news showed, not one cared about Novak’s comments at all.

A little less emphasized than the positive news about earnings was the acknowledgement by Yum! that:

KFC sales in the last two weeks of the fourth quarter were significantly impacted by the intense media attention surrounding an investigation by the Shanghai FDA (SFDA) into poultry supply management at Yum! China. The investigation was prompted by a report broadcast on China’s national television (CCTV), which aired on December 18, 2012. The report showed that a few poultry farmers were ignoring laws and regulations by using excessive levels of antibiotics in chicken. Regrettably, some of this product was purchased by two poultry suppliers of KFC China. The investigation caused further media attention, including social media commentary, and this negatively affected consumer perceptions of poultry safety, and KFC in particular.

Consequently:

We are confident the YRI and U.S. businesses will deliver annual operating profit growth consistent with our ongoing growth model. Given current uncertainties related to KFC sales in China, it is difficult to confidently forecast our overall financial performance. We have made the assumption that KFC China same-store sales will improve as the year progresses and will be positive in the fourth quarter. With these assumptions, we estimate a mid-single digit EPS decline in 2013 versus prior year, excluding Special Items. This includes an expectation for a significant decline in EPS performance in the first half of the year followed by EPS growth in the second half.

Investors were furious.

Yum! has made a habit of bragging that its store chain in total locations now matches that of McDonald’s Corp. (NYSE: MCD) worldwide, and Yum! may have surpassed the long-time champion. Yum’s China revenue has been almost miraculous, led by sales of KFC products.

It was only two quarters ago that management stated the following:

Yum! China, our largest profit-contributing division, reported strong system sales growth of 27%, prior to foreign currency translation. However, operating profit declined 4%, prior to foreign currency translation, as high inflation drove restaurant margins down 4 percentage points versus last year. We expect this to be short-lived, returning to double-digit profit growth in the second half of the year. Our outstanding China team now expects to open a record of at least 700 new units this year.

Yum!’s China plans quickly have fallen into disarray.

Interbrand recently valued KFC’s global brand at $6 billion. That is equivalent to a quarter of Yum!s market cap, and ahead of the value of brands such as Tiffany and Porsche. That brand valuation, so critical to the perception of Yum!’s share price, has been badly damaged, particularly in China. With it, so have Yum!’s longer term prospects of hyper-rapid growth. Earnings are important. Reputation is invaluable.